On March 8, the Bank of Canada announced that it would maintain its benchmark interest rate
at 4.5 percent and pause raising borrowing costs as it had been doing for the past year. The
central bank also stated that future rate hikes are possible if inflation does not slow as quickly as
expected.
Since March 2022, the Bank of Canada has raised its overnight rate eight times in a row in an
attempt to slow the rate of price growth and cool the overheated economy. Consumer price
inflation peaked in June 2022 at 8.1 percent, a four-decade high, and has since steadily declined.
In January 2023, the annual inflation reading fell to 5.9 percent from 6.3 percent in December
2022, although food prices kept rising to 10.4 percent from 10.1 percent in December.
Analysts say much of the decline in inflation has come from falling oil prices as well as a drop in
durable goods inflation, resulting from lower shipping costs and less consumer demand.
According to the Central Bank of Canada, core inflation measures, which attempt to remove the effects of more volatile items, are rising at a rate of about 5 percent annually, and three-month core measures are rising at a rate of about 3.5 percent.
Inflation continues busting consumers’ budgets
While inflation remains high, bank officials believe they have done enough to guide it back down to the bank’s 2-percent target over time. The bank anticipates that consumer price inflation will fall to around 3 percent by the middle of the year.
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The central bank is now in a holding pattern as a result of its decision on Wednesday, March 15. The bank, however, stressed that this is a “conditional” pause and that it is ready to raise rates again if inflation remains stubborn or the economy proves more resilient than expected.
“The Bank of Canada needs a clearer picture on growth and inflation prospects to decide if it
needs to hike again or more definitively set aside that prospect,” Canadian Imperial Bank of
Commerce chief economist Avery Shenfeld wrote in a note to clients. “And with so little time
since its last decision, it simply doesn’t have enough data to make that call.”
Economic data is both positive and negative. GDP growth stalled in the fourth quarter of 2022,
falling far short of the central bank’s forecast. Many Bay Street analysts agree with Governor Tiff Macklem’s prediction of a “mild recession” in Canada in the coming quarters, economic growth is expected to be near zero through the first half of 2023.
Meanwhile, the labour market in Canada has been performing exceptionally well, despite initial
predictions. In January, employers in the country added 150,000 jobs, which is ten times more
than what Bay Street analysts had anticipated. Furthermore, the unemployment rate has
remained steady at 5 percent, close to its record low, and wages have continued to increase by 4
to 5 percent on a year-over-year basis.
Macklem has said that the current rate of wage growth is not in line with the Bank’s goal of
keeping inflation at 2 percent, and he says that a rise in unemployment is needed to control price
growth.
For inflation to keep falling, there will also need to be a slowdown in service price inflation,
which is driven to a large extent by wages.
The central bank’s rate pause is good news for the housing market, according to Karen Yolevski,
chief operating officer at Royal LePage, one of Canada’s biggest real estate companies. Yolevski
believes that the greater predictability surrounding mortgage rates could encourage hesitant
buyers to return to the market, which could potentially boost home sales volumes and prices in
the upcoming spring season.
“People want some certainty around what they’re going to pay, and they are looking to see where those rates settle down,” Yolevski said in an interview.
“And in terms of mortgage holders, certainly for those who have variable rate products, there’s a sigh of relief that the interest rate has remained steady this time around,” she said.
Weaker Canadian dollars
The bank’s decision to hit pause makes the Bank of Canada the first major central bank to halt
monetary policy tightening and puts it at odds with the U.S. Federal Reserve. U.S. officials have
signalled that the Fed expects to increase interest rates several more times.
In testifying before Congress on March 7, U.S. Federal Reserve Board chairman Jerome Powell
said, “The latest economic data [of the U.S.] have come in stronger than expected, which
suggests that the ultimate level of interest rates is likely to be higher than previously
anticipated.”
The difference between the U.S. and Canada’s plans for rate policy could make the Canadian
dollar weaker on foreign exchange markets. Still, if the Canadian dollar fell even more against
the U.S. dollar, which it has done a lot since last summer, imports would cost more, which would make inflation worse.
“Aggressive rate increases by the Fed might put pressure on the BoC to also raise rates. But we
expect the BoC will likely remain on hold unless the Fed funds rate moves to the 5.5 percent
range—pushing the spread to 100 basis points—and forcing the BoC to hike rates to avoid a
much weaker CAD and higher import prices,” said Tony Stillo, director of economics at Oxford
Economics, in a March 8 note.
